hat do you say about a department that last year overpaid contractors $180 million, sent checks to hundreds of dead people and couldn't reconcile $18 billion in payments with its accounting records?

If you're John Hamre, Defense Department comptroller and steward of the coffers of the agency responsible for 50 percent of the government's discretionary spending, you say, "We're making a lot of progress."

"But you have to know how bad we were to appreciate that," he adds.

The Pentagon's finance and accounting problems are legendary. In 1993, the year Hamre arrived at the Pentagon, the department overpaid contractors by more than $600 million and made $50 billion in payments that could not be matched against obligations entered in accounting ledgers. The year before, the Pentagon had miscalculated the pay for thousands of Gulf War veterans, some of whom didn't realize they had been overpaid until they were contacted by debt collectors hired by the Pentagon to recoup the overpayments many months after the war. At the same time, hundreds of dead people were sent regular paychecks until the error was discovered after a fraud-prevention program was initiated by the department in 1994. The ongoing program continues to uncover such payments.

Against that backdrop, the Pentagon's record last year is an improvement. But it may not be enough to satisfy members of Congress, who believe the Pentagon has not done enough to correct its long-standing financial management problems.

In particular, the Defense Department failed to comply with provisions in the 1990 Chief Financial Officers Act and the 1994 Government Management Reform Act, which require DoD to annually produce audited financial statements departmentwide and for each of the military services. Not only is the department unable to produce auditable financial statements now, it is years away from being able to do so, Pentagon officials say.

As the Defense Department comes under increasing budget pressure, patience is running out among lawmakers and Pentagon officials who believe financial management reform is critical to maintaining adequate levels of troops and equipment in the future.

"This is not a bean-counting exercise," says one Senate staffer, who asked not to be identified. "We need to have the data to support intelligent decisions in a restrained budget environment. The only way to make effective decisions is to have good financial data." As Congress and the Pentagon weigh trade-offs between modernizing the force and maintaining readiness and troop levels, the information is critical, the staffer says.

"In a time of budgetary constraints [the Pentagon] has to change the way it does business or it's going to threaten national security. We have to have decent planning, based on data you can measure; we need information systems that don't just automate the existing way of doing business," the staffer says.

'Worst in Government'

The department that pioneered electronic funds transfers-technology millions of Americans enjoy as their paychecks are deposited directly into their bank accounts-is drowning in a sea of paper records that clerks routinely retype because the department's myriad finance and accounting computers cannot communicate with each other.

For a department that manages more than $1 trillion in assets, 3 million personnel and an annual budget of $250 billion, this is a huge problem. There's no comparable scope of responsibility elsewhere in government or in the private sector. For that reason, there are no models for what Pentagon officials and lawmakers hope to accomplish over the next few years-the creation of a network of finance and accounting systems invulnerable to fraud, waste and abuse, that operate together seamlessly, at lower cost and with fewer personnel, and provide military planners with accurate and timely financial data and employees and contractors with accurate and timely compensation.

Given the current state of financial affairs at the Pentagon, it may not be possible. In an unusually blunt report issued in February, the General Accounting Office noted, "This situation is one of the worst in government and is the product of years of neglect." The report, "Defense Financial Management," was one of a series issued by GAO that focused on federal program areas at high risk of waste, fraud, abuse and mismanagement.

"Auditors' reports have confirmed that DoD does not have accurate cost data for almost all of its non-cash assets, such as inventories, equipment, aircraft, and missiles, nor can the department accumulate reliable information on the cost of its business activities and critical operations, such as the costs associated with maintaining its weapon systems in a high state of readiness," GAO reported.

GAO's review of Navy financial operations found that billions of dollars associated with building aircraft and missiles and modernizing weapons systems were not reported. Such data is critical for military planners as they consider spending billions on new weapons systems, lawmakers say.

Undersecretary of Defense for Acquisition and Technology Paul Kaminski says many of the department's acquisition reforms are tied to financial management reform. "In many cases, it is a must that [finance and acquisition personnel] work together to achieve the greatest impact and savings for the government," he says. While he says he is content with the pace of reform at DoD, others are less patient.

"The need for DoD to achieve effective control over its payment process is imperative. If it does not, it continues to risk erroneously paying contractors millions of dollars and perpetuating other financial management and accounting control problems," GAO wrote in another report in its high-risk series, "Defense Contract Management." GAO cited several factors that have contributed significantly to errors in DoD's payment process:

Data are often entered into finance and accounting systems manually, sometimes from erroneous or incomplete documents.

Multiple documents must be matched before contractors can be paid.

Payments are allocated among numerous accounting classifications, sometimes introducing errors and adding to the cost of processing invoices.

GAO also found that existing financial data did not reliably portray actual costs associated with base closure and realignment options. The lack of such critical information is setting off alarm bells on Capitol Hill.

"The effect of these high-risk problems is not academic," said Sen. Fred Thompson, chairman of the Senate Committee on Governmental Affairs, at a May 1 hearing on Defense management problems. "DoD will not be able to afford to modernize its weapons systems and maintain readiness at current levels. A further budget crunch can be foreseen as optimistic expectations of savings from acquisition reform, base closing and privatization efforts based on improved management will not be realized."

Richard Keevey, director of the Defense Finance and Accounting Service (DFAS), which was created in 1991 to consolidate and improve the department's finance and accounting systems, agrees that providing auditable financial statements is an important goal. But "we have other more important goals in the short run," he says, such as eliminating overpayments to contractors, matching payments to accounting system obligation records and paying contractors on time to cut interest accrued on late payments.

"Under a good finance and accounting network, you would never make a payment until you check it against the underlying obligation and the underlying records," Keevey says. Because DoD's systems are so antiquated this process has been tremendously cumbersome.

Revolutionary Change

"The traditional way of doing business at DoD was make the payment and then go back and look for it in the accounting records," Keevey says. In an effort to pay contractors on time and avoid interest on late payments, finance personnel would authorize contractor payments as long as they had what they believed was adequate documentation supporting the payment. The problem arose when they later tried to match the payment with what was actually entered in accounting records.

Not only were payments made before they were reconciled with accounting re-cords, the checks were often drawn on accounts that were in the red. When Hamre, shocked to discover the practice, decided to freeze such payments until the discrepancies could be straightened out, he immediately came under fire from Defense contractors and their allies on Capitol Hill.

"Believe it or not, that was a revolutionary change in DoD," says Keevey. "It was common practice to run accounts into the red up through 1994."

Last year, the Defense Department paid out $18 billion that it has not yet been able to match to accounting records. Half of those "problem disbursements" are payments that are still considered "in transit"-they have been reported to the Treasury but either haven't been received by the appropriate Defense accounting station or are in the accounting station's backlog. As bad as the $18 billion figure may seem, there were nearly three times as many problem payments in 1993, when DoD began seriously looking at the issue.

"Each year we've reduced some of the backlog," says Keevey. "Some other problems develop in the meantime and we address them. Our long-term goal is obviously to have none of these."

To eliminate payment-matching problems entirely, DoD officials began matching payments exceeding $5 million on existing contracts to accounting records before the checks are cut, even if it means accruing higher interest payments. Last year the threshold was lowered to $4 million on existing contracts, and this month it will be lowered again to $3 million. Beginning last October, all new contract payments have to be matched to accounting records before payment, regardless of the amount.

The most serious incidents of problem disbursements have occurred at the DFAS center in Columbus, Ohio, where bills for most large weapons systems are paid. The center has been plagued by problems since 1989, when hundreds of thousands of Defense Contract Management Command records were consolidated in Columbus before DFAS was created. Record keeping has been poor and the finance system does not share data with the accounting system. In 1993, the center overpaid contractors $600 million. Overpayments dropped to $180 million last year, but the Columbus center will continue to have problems until it upgrades its finance and accounting systems, Keevey says.

"Interest payments at Columbus went from $7 million to about $15 million. That is one of the drawbacks, but it is in my view an acceptable drawback. It is better for us to pay [interest on late payments] than to have poor accounting records. Our job is to eliminate both of them. The only way to ultimately eliminate both is to have improved accounting records," Keevey says.

Dissecting a Body

At the heart of DoD's financial mess is a tangle of antiquated finance and accounting systems that do not share information electronically. Employees operating the systems often follow procedures unique to their agency or service, further complicating communication across the department, where hundreds of clerks are consigned to retrieving and entering data manually, often from poorly maintained paper records.

Integrating this tangle of finance and accounting systems and all the other information-tracking systems that feed data into them will be necessary if the Pentagon is ever going to produce auditable financial statements. Achieving this will be about as easy as dissecting a body to remove the veins, without touching any of the muscles or nerves, Hamre says. "It's a remarkably hard thing to do, partly because you can't skip a beat on daily operations."

The daily operations are considerable: Every two weeks, the department cuts 5 million paychecks. Every month it processes 600,000 travel invoices and 900,000 non-travel invoices.

"You can't just stop what you're doing and get a new system that's perfect," Hamre says. "You have to keep doing business every day. What you have to do is buy a new accounting system and engineer it into the business practices of every organization you're working with-and we have thousands."

When DFAS was formed, the Defense Department had 127 separate finance systems to make payments, and 197 separate accounting systems to record contract data. In addition, there are hundreds of other "feeder" systems that send data to the various accounting and finance systems. By last year, DFAS had consolidated those to 67 finance systems and 150 accounting systems, and has a goal of eventually reaching nine finance systems and 23 accounting systems. DFAS is consolidating all its activities into five centers and 21 operating locations.

"Each service and each individual Defense agency was its own fiefdom," Keevey says. After DFAS was created, each service and agency negotiated with DFAS what services DFAS would provide. For that reason, there is little consistency among services and agencies in the activities DFAS performs. For instance, DFAS performs most of the Army's financial operations, but only about half of the Air Force's and 30 percent of the Navy's. This inconsistency has made standardization more difficult.

"I suspect [the different agreements] were what we needed to build consensus and get this going," says Keevey, who did not arrive at the department until 1993, two years after DFAS had been created. He has asked his staff to review the agreements with the military services and propose areas for greater standardization.

One area where DFAS has been particularly successful, however, is in the area of civilian pay, a service DFAS performs departmentwide. In 1991, there were 25 separate pay systems for civilian employees. Each military service and Defense agency had several different systems for paying civilians. Defense officials count it as a victory that they have whittled those down to two systems. By the middle of next year, there will be one pay system for civilian employees across DoD.

Despite such successes, GAO auditors are guarded in their assessment of the Pentagon's prospects for financial improvement. The auditors noted in their report on financial management, "DoD's financial management operations are plagued with duplicative processes and business practices that are complex, slow, and error-prone." For example, before DoD revamped its travel processes, the average traveler had to go through 40 steps to get travel authorization and reimbursement. In addition, there were more than 700 processing centers and 1,300 pages of regulations affecting travel. GAO praised the department's broad approach to reengineering travel procedures but says other financial management reforms have done little to address overly bureaucratic existing practices.

"Successfully reengineering the department's business processes is critical if DoD is to effectively address deep-rooted organizational emphasis on maintaining 'business as usual' across the Department," GAO concluded.

Few at DoD would disagree. Therein lies cause for optimism.

HAMRE TIME

Defense Comptroller John Hamre has four priorities for reforming financial management at Defense:

1.Downsize the finance and accounting structure.
In 1993, there were 333 offices doing finance and accounting, any one of which could write a check on anybody else's account. About 240 offices have been consolidated; 60 more are slated to be consolidated this year.

2.Reform internal business practices.
The department has stopped such practices as writing checks on accounts that are in the red and is working to adopt better means of tracking obligations and payments to cut down the number of problem disbursements.

3.Get non value-added transactions out of the finance business.
Finance and accounting personnel are "choking on irrelevant details," Hamre says, such as processing five copies of receipts for travel invoices.

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